Blamestorming and “Deregulation caused the financial crisis” [Good Life series]

You’ve heard the claim: “Deregulation caused the crisis.” In the years leading up to 2008, the story goes, bad economists convinced bad politicians to deregulate the money/banking/finance sector of the economy, and bad capitalists then enjoyed an orgy of greed that caused the system to go haywire.

Nobel-Prize-winners Joseph Stiglitz and Paul Krugman have signed on to this story. Krugman, for example, has long championed increased regulation of financial markets, and he recently complained in The New York Times that the politicians have failed to listen to the advice of the right economists. “The world,” he says, “would be in much better shape than it is if real-world policy had reflected the lessons of Econ 101,” and Econ 101, he believes, teaches that more controls (and more government spending) would have prevented the crisis.

So now let us turn to Round Two of blamestorming about the financial crisis. Round One took up the (silly) claim that free-market academics dominate the economics profession and have sway over politicians and regulators. (See “Where are All Those Free-Market Economists Who Caused the Financial Crisis?”) In this next round, let’s look at what politicians did and the trajectory of government regulation in the lead-up to 2008.

How do we tell whether regulation has increased or decreased?

One crude method is to count the number of pages in the U.S. Federal Register, which is the government’s daily publication of new and proposed rules. Some of the rules are trivial and some have large impact; some are proposed and some are final; some are clarifications and some are new. But cumulatively the Register‘s increasing or decreasing bulk tells us something about regulatory trends.

For the last generation, here are the Federal Register‘s total page counts for selected years:
1980s: 52,992 pages per year average.
1990s: 62,237 pages.
2005: 73,870 pages.
2010: 81,405 pages.

More sophisticated data now exist, such as those found at the invaluable RegData site. The RegData social scientists count the number of regulations, break them down by economic sector, and attempt to sort the minor from the major regulatory changes (and they let you make your own cool charts). The data unequivocally show that the overall number of regulations increased in the 1990s and on through in the early 2000s. If we focus only on regulation of the financial sector, the data also show an increase in the amount of regulation.

Yet another measure of regulation is how much the federal government spends to craft and enforce rules in various sectors: consumer safety, environment, energy, homeland security, and so on. The more the government is regulating, the higher its budget should be; and the less government is regulating, the lower its budget. So, courtesy of economists Veronique de Rugy and Melinda Warren, here are the federal government’s budgeted spending numbers for the Finance and Banking sector of the economy (in constant 2000 dollars) from 1960 to 2008:

1960: $190 million
1970: $356 million
1980: $725 million
1990: $1.598 billion
2000: $1.965 billion
2007: $2.065 billion
2008: $2.294 billion

Still another measure is the number of government personnel employed in crafting and enforcing regulations. The numbers for Finance and Banking:

1960: 2,509
1970: 5,618
1980: 9,524
1990: 15,308
2000: 13,310
2007: 11,637
2008: 12,113

So some questions: When did the supposed downturn in the number of regulations occur? When were the layoffs of regulators who, sadly, had to find other employment? And where are the big cuts in the budgets of the regulatory agencies devoted to policing the financial markets?

They don’t exist. But they are necessary for the Deregulation caused the crisis! claim.

So why the persistence of the claim despite the historical record? Some of it is knee-jerk ideological, of course. A crisis happens, and many immediately point fingers at their political enemies: My theory tells me that they must be responsible for the world’s ills.

But the trajectory of government regulation clearly increased, so more sophisticated advocates of the Deregulation caused it! thesis turn to a more subtle version of the meme. They will grant that regulation as a whole increased but claim that certain specific deregulations also occurred, and those specific deregulations caused the mess.

And here the big culprit is: Glass-Steagall!!!

Glass-Steagall was partly repealed in 1999 by President Bill Clinton. Joseph Stiglitz, for example, blames the repeal and notes it was against his advice. Glass-Steagall was initially put in place in 1933 to segregate commercial and investment banks. Commercial banks were not allowed to invest in securities, and investment banks were not allowed to accept deposits.

But the vast majority of economists and politicians see Glass-Steagall as irrelevant to the crisis. The financial institutions that were in huge trouble — including Fannie Mae, Freddie Mac, Bear Stearns, AIG, and Lehman Brothers — none of them would have been subject to Glass-Steagall’s provisions. Even President Obama has gone on record in Rolling Stone in agreeing that Glass-Steagall is not relevant.

(And notice the implicit model of how economies work, if we are to think that a partial repeal of Glass-Steagall is the culprit: bureaucrats will issue thousands and thousands of regulations — but if they get one rule wrong, the whole thing’s gonna collapse.)

At this point, fans of increased regulation shift ground. Instead of blaming deregulation, they suggest that a lack of new regulation is to blame. Yes, the amount of government regulation increased before the crisis, they will grudgingly admit, but the economy grew at an even faster rate and government regulators couldn’t or didn’t keep up.

This raises an intriguing new set of issues, and perhaps an analogy to soccer or any sport is helpful here. Suppose that soccer becomes increasingly popular and more matches and leagues come into existence. Does it follow that we need to increase the number of soccer rules? Or that we need to hire more soccer referees? Or is a better analogy that people are inventing brand new sports, all of which require new rules and more regulators? But does it even follow that government should make up the rules for the new sports — aren’t players and the leagues and the sports associations themselves capable?

All good questions. But note that we have now moved decisively away from the Deregulation hypothesis, as we should. Deregulation means that existing practices were unleashed. Innovation is when new practices come into existence. So if we are to blame new financial instruments, then we should be criticizing innovation rather than deregulation.

All of this matters to all of us, whether we are average voters or professional policy-makers, because the Deregulation caused the crisis thesis carried the day in frantic policy circles as the crisis became apparent, and since 2008 the amount of regulation has increased on an accelerating trajectory.

But if the data show that regulation was increasing in the lead-up to the crisis, then that policy reaction was the wrong one — and one that has mis-diagnosed the problem, wasted huge amounts of money, stifled recovery activity, and set the stage for worse problems down the road.

And since the data do show increased regulation before the crisis, perhaps we should consider some heretical suggestions: Maybe all of the regulations caused the problem. Maybe centralized control is the fly in the ointment. And maybe — just maybe — asking politicians and their appointees to run something as complex as a modern economy is just asking for trouble.

[This article was originally published in English at and in Portuguese at]

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